Can share transfers be controlled?
Source: The Hindu Business Line
There’s raging controversy over how the restrictions on such transfers can be enforced
Many shareholder agreements contain clauses that restrict buyers from selling shares freely. However, whether such restrictions can be enforced is debatable, and is now the subject matter of controversy.
Consequently, whether the board of a company, whose shares are covered by such agreements, is bound by such restrictions, and whether such restrictions are contrary to legislative intent or the by-laws of the company, remain unresolved.
The relevant portion of Section 111A of the Companies Act, 1956 states: “…the shares or debentures and any interest therein of a (public) company shall be freely transferable: provided that if a company without sufficient cause refuses to register transfer of shares…the transferee may appeal to the Tribunal and it shall direct such company to register such transfer of shares.”
The Delhi, Bombay and Gujarat High Courts had previously interpreted contractually agreed share transfer restrictions as being violative of the ‘free transferability’ provisions under the Section 111A. However, recent decisions of the Bombay High Court have turned in favour of shareholders, by recognising their rights to enter into such arrangements.
Examples include the Messer Holdings Ltd vs Shyam Madanmohan Ruia case and the Western Maharashtra Development Corporation Ltd vs Bajaj Auto Ltd.
In the Messer Holdings case, the Bombay High Court recognised the rights of shareholders to voluntarily enter into binding contracts.
The Bombay High Court also thought that the intended meaning of Section 111A was to restrict the directors of a company from refusing to register share transfers, except in accordance with applicable laws.
The Bajaj Auto case reiterated this. In that case, the Bombay High Court further clarified the intent of Section 111A, tracing its origin to Section 22A of the erstwhile Securities Contracts (Regulation) Act, 1956, which was to ensure that the board of directors is prohibited from refusing to register share transfers.
The Bombay High Court therefore resolved that “free transferability” did not impede on two shareholders’ rights to enter into consensual agreements to deal with their shares, either at the time of contracting or in the future.
The Companies Act, 2013 appears to resonate the above views by introducing a proviso to Section 58 (2), which states: “Any contract… between two or more persons in respect of transfer of securities shall be enforceable as a contract.”
This proviso, however, fails to fully resolve the controversy. While it addresses and recognises the right of individual shareholders to contractually agree on share transfer restrictions, whether such restrictions can bind a board of directors is not very clear.
Another interesting decision is that of the Supreme Court in the VB Rangaraj vs VB Gopalakrishnan case, which discusses the interplay of contractual arrangements inter se shareholders and the by-laws of a company.
The judgment draws reasoning from Section 82 of the 1956 Act, which provides that shares are movable property that may be dealt with in the manner provided for in the by-laws of a company.
Accordingly, the only restrictions on the transfer of shares of a company that are enforceable are those that are incorporated in its by-laws.
However, the three-judge bench of the Supreme Court in the Vodafone International Holdings BV vs Union of India & Anr case rightly departed from the view taken in the Rangaraj case, stating that none of the provisions of the 1956 Act prevent shareholders from entering into agreements providing for voting rights attached to their shares or share transfer arrangements.
It appears that the Bombay High Court in the Messer Holdings case as well as the Supreme Court in the Vodafone case have taken the view that irrespective of the terms of the share transfer agreements being incorporated into the by-laws, such agreements would be valid under general applicable laws and binding on the contracting parties.
While we concur with the view of the division bench of the Bombay High Court in the Messer Holdings case — that it should not be mandatory for such contractual restrictions on share transfers to be incorporated in the by-laws of a company — such incorporation is advisable.
It would make such restrictions binding on the company and prevent it from undertaking actions that are ultra vires the by-laws. The Messer Holdings case is presently before the Supreme Court. One hopes that the apex court will be guided by legislative intent and uphold the freedom of parties to impose restrictions on themselves.